National Association of Home Builders Discusses Economics and Housing Policy

Strong Q2 GDP Growth Confirmed

The pace of growth in the nation’s economy over the second quarter of 2017 was stronger than originally believed. According to the Bureau of Economic Analysis within the U.S. Department of Commerce, real gross domestic product (GDP) is now estimated to have increased by a seasonally adjusted annual rate of 3.0 percent in the second quarter. The original or “advance” estimate for the quarter was 2.6 percent.

On an accounting basis, greater contributions to overall GDP growth were estimated for personal consumption expenditures, gross private domestic investment, and net exports of goods and services. Meanwhile, government consumption, which contributed 0.1 percent point to overall growth in the “advance” estimate, subtracted 0.1 percent point from growth after the second estimate. The switch from a positive to a negative contribution reflected a larger decline in state and local government consumption expenditures.

The upward revision in GDP growth confirms that the growth of the economy was stronger in the second quarter than it was in the first quarter of 2017. However, residential fixed investment (RFI) has been more volatile. Even after accounting for a 0.3 percentage point upward revision, RFI fell by 6.5 percent over the second quarter. However, the decline in the second quarter of 2017, which was confirmed by the second estimate of GDP, reflects some reversal following the strong growth in the first quarter that was partly related to unseasonably warm temperatures.

Comparing the current level of GDP with “potential output” suggests that the economy has returned to its long-term potential level of output. Although the Federal Reserve Bank of New York notes that “capacity utilization remains below their historical averages suggesting that more resource slack than other activity measures.” The red line in the above chart shows the level of GDP, with its accompanying business cycles. The blue line is an estimate of potential output by the Congressional Budget Office. Intuitively, potential output is the maximum amount of production that is consistent with an efficient and full utilization of the nation’s resources.

As illustrated by the figure above, the “output gap”, the difference between potential output and actual GDP has nearly disappeared, suggesting that little to no resource slack remains in the economy. The tight labor market is another indicator that little resource slack remains in the economy. The near disappearance of the output gap since the recession largely reflects growth of the U.S. economy. At the same time the convergence between potential output and actual GDP also reflects a decline in the trend of potential output following the recession. In other words, the sustainable long-term trend of the U.S. economy declined somewhat following the most recent recession, a phenomenon that is not visible following the 2001 recession.

However, assessing the extent of recovery depends on the measure of potential output used. Economists from Wells Fargo Securities LLC, demonstrate that the most recent estimation of potential output is well below its estimate in 2007, just prior to the recession. They show that even though the gap between actual GDP and the most recent vintage of potential GDP is nearly closed (as updated in the slide above), actual GDP remains well below the level of potential output that was calculated just prior to the recession. This indicates that actual GDP has not returned to its pre-recession potential level.

At the same time, since actual GDP is virtually equal to the most recent estimate of potential GDP, then a gap also exists between the current estimate of potential output and the 2007 vintage of potential output. The Wells Fargo economists use this gap between the pre-recession estimate of potential output and the current one to assert that “the damages from the Great Recession are not temporary (or transitory) as the 2015 level of potential GDP based on vintage 2007 is significantly higher than the level estimated in 2016. This suggests that damages from the Great Recession are long lived.”

Over the near-term, GDP growth is expected to continue. However, several near-term risks to the pace of growth are emerging. First, the damage by Tropical Storm Harvey could lower growth in the short-term. However, the storm is not expected to shift underlying fundamentals and a recovery should ultimately take place. At the same time, a shutdown of the federal government is possible. Although estimating its implications for the economy is subject to uncertainty, the directly measured impact would depend on whether a federal government shutdown takes place, which employees are affected, and the length of time that the government remains shut down. However, if it takes place, its impact is expected to be short-lived.